Tax Analysts Blog

Zero Is the Loneliest Number, at Least for Presidential Candidates and Their Taxes

Posted on Oct 14, 2016

When it come paying taxes, how much is too little?

The answer depends on whether you're running for president. Ever since someone leaked portions of Donald Trump’s 20-year-old state tax returns, people have been speculating about the taxes he paid – or didn’t pay, as the case may be.

Tax avoidance has been a volatile issue in American politics for more than a century – ever since the income tax put a premium on tax planning. Experts have debated the moral status of avoidance, with some insisting on the taxpayer's legal right to minimize tax liability and others invoking a supra-legal moral responsibility to pay a vaguely defined "fair share." 

But one fact is clear from this long-running debate: In politics, if not in law, the moral status of tax avoidance varies with the avoider's effective tax rate. More specifically, zero is a hard number to defend.

The contested morality of tax avoidance (or tax minimization) was on full display during the 2012 presidential election, thanks to Mitt Romney and his two numbers.

On the one hand, Romney’s personal tax returns revealed a 14 percent effective tax rate – low for a presidential aspirant, but hardly surprising. More damaging was another tax-related number. "These are people who pay no income tax," he told a group of donors in the midst of his campaign.  "Forty-seven percent of Americans pay no income tax. So our message of low taxes doesn't connect."

Romney’s description of “the 47 percent” was a political disaster. But it was also well within the bounds of American political discourse over taxation and civic responsibility. Over the years, leaders of both parties have been known to decry the existence of nonpayers, and poll results have confirmed that many Americans consider taxpaying -- perhaps better described as tax participation -- to be a moral responsibility.

Our national debate over tax avoidance can be encapsulated in three remarks. On the one side is Judge Learned Hand. "Any one may so arrange his affairs that his taxes shall be as low as possible," he wrote in Helvering v. Gregory in 1934.  "He is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one's taxes."

Also on point is another of Hand's observations. "Over and over again courts have said that there is nothing sinister in so arranging one's affairs as to keep taxes as low as possible," he wrote in his dissent in Commissioner v. Newman .  "Everybody does so, rich or poor; and all do right, for nobody owes any public duty to pay more than the law demands: Taxes are enforced exactions, not voluntary contributions. To demand more in the name of morals is mere cant."

If Hand's defense of tax avoidance was powerful, so were the indictments of aggressive tax minimization offered up by his contemporary, President Franklin Roosevelt. "When our legitimate revenues are attacked, the whole structure of our government is attacked," FDR told Congress in a special message.  "Clever little schemes are not admirable when they undermine the foundations of society."

If Hand and Roosevelt saw tax avoidance differently, so did other public figures. In general, tax avoidance has spawned a lot of overheated rhetoric and vibrant political theater, including legislative drives to close “loopholes.” In fact, arguments over tax avoidance are something of a set piece in American politics, often set in motion by Democrats trying to mobilize political support on the left.

Arguments over avoidance have gotten especially heated when tax liabilities have fallen to zero. At several pivotal moments, Americans have been transfixed and outraged by revelations that some members of the nation's economic elite have managed to incur no tax liability. These well-heeled “lucky duckies” have presented an irresistible target to the kind of politician who traffics in populist outrage.

One famous example occurred in January 1969, when acting Treasury Secretary Joseph W. Barr told Congress that 155 taxpayers with adjusted gross incomes greater than $200,000 (and 21 earning more than $1 million) had paid no income tax the year before. The resulting outcry prompted Congress to develop the nation's first alternative minimum tax.

But the 1969 episode was not the first. More than three decades earlier, a similar disclosure about millionaire nonpayers prompted Congress to revamp the tax treatment of losses.

In May 1933 Congress was transfixed by the public hearings of the Pecora Commission, an investigating panel convened by the Senate Banking Committee and led by former New York prosecutor Ferdinand Pecora. Charged with uncovering the causes of the 1929 stock market crash, Pecora hauled a string of Wall Street titans into his congressional hearing room, including the most famous of them all, J.P. Morgan Jr.

"Morgan Paid No Income Tax for the Years 1931 and 1932," reported The New York Times on May 24, 1933. The resulting outrage was immediate and overwhelming. "What has rankled most in the hearts of the vocal public, is that when millions of persons with small incomes were straining every nerve to meet their income taxes, these princes of wealth, who personally enjoyed luxuries denied to almost everyone else, did not pay any income tax at all," declared The New Republic.

As it turned out, Morgan's lack of tax liability was "perfectly legal," to use the well-worn phrase as popular then as now. Morgan and his partners had taken huge losses during the market crash, wiping out their income from other sources. Morgan was quick to point out that such losses were hardly good news, even if they helped him avoid taxes. "I am not responsible for these figures," he insisted archly.  "I viewed them with great regret when they appeared."

But if Morgan had the law on his side, he had politics against him. "The country, in 1933, was in no mood for nice distinctions between tax 'evasion' and tax 'avoidance,'" Pecora recalled in his memoirs. "Approved by the existing tax authorities or not, the public could not see the justice or equity of financial giants paying nothing, while Tom, Dick, and Harry scraped the bottom of their modest purses to meet their tax obligations to the government." Congress moved quickly to limit loss deductions, ignoring the complaints of tax experts that such limits were unreasonable.

The Pecora episode illuminates the complexity of tax avoidance debates in U.S. politics. For the most part, Americans have tolerated tax minimization, even among the rich.

But they have a hard time accepting minimization when it reduces liabilities to zero. And it's important to recognize that popular discomfort with nonpayers is not entirely a class issue. Yes, it has been most potent when the taxpayers in question have been wealthy. But as Romney understood when talking about the 47 percent (now reduced to 44 percent, according to estimates from the Urban-Brookings Tax Policy Center), Americans are uneasy with any class of nonpayers – rich and poor alike.

A longer version of this article, including additional discussion of the Pecora investigation, can be found on the Tax Analysts website.

In May 1933 Congress was transfixed by the public hearings of the Pecora Commission, an investigating panel convened by the Senate Banking Committee and led by former New York prosecutor Ferdinand Pecora. Charged with uncovering the causes of the 1929 stock market crash, Pecora hauled a string of Wall Street titans into his congressional hearing room, including the most famous of them all, J.P. Morgan Jr.

“Morgan Paid No Income Tax for the Years 1931 and 1932,” reported The New York Times on May 24, 1933. The resulting outrage was immediate and overwhelming. “What has rankled most in the hearts of the vocal public, is that when millions of persons with small incomes were straining every nerve to meet their income taxes, these princes of wealth, who personally enjoyed luxuries denied to almost everyone else, did not pay any income tax at all,” declaredThe New Republic.

As it turned out, Morgan’s lack of tax liability was “perfectly legal,” to use the well-worn phrase as popular then as now. Morgan and his partners had taken huge losses during the market crash, wiping out their income from other sources. Morgan was quick to point out that such losses were hardly good news, even if they helped him avoid taxes. “I am not responsible for these figures,” he insisted archly.  “I viewed them with great regret when they appeared.”

But if Morgan had the law on his side, he had politics against him. “The country, in 1933, was in no mood for nice distinctions between tax ‘evasion’ and tax ‘avoidance,’” Pecora recalled in his memoirs. “Approved by the existing tax authorities or not, the public could not see the justice or equity of financial giants paying nothing, while Tom, Dick, and Harry scraped the bottom of their modest purses to meet their tax obligations to the government.” Congress moved quickly to limit loss deductions, ignoring the complaints of tax experts that such limits were unreasonable.

The Pecora episode illuminates the complexity of tax avoidance debates in U.S. politics. For the most part, Americans have tolerated tax minimization, even among the rich.

But they have a hard time accepting minimization when it reduces liabilities to zero. And it’s important to recognize that popular discomfort with nonpayers is not entirely a class issue. Yes, it has been most potent when the taxpayers in question have been wealthy. But as Romney understood when talking about the 47 percent (now reduced to 44 percent, according to estimates from the Urban-Brookings Tax Policy Center), Americans are uneasy with any class of nonpayers – rich and poor alike.

A longer version of this article, including additional discussion of the Pecora investigation, can be found on the Tax Analysts website.

For more tax talk follow me on Twitter @jthorndike.

Read Comments (1)

Mike55Oct 17, 2016

I have a hard time understanding why the Trump NOL is creating so much angst, even after reading this outstanding article. The primary difference between Morgan in the 1930s and Trump in the 1990s is that Morgan still had WEALTH. The average U.S. citizen understands that we tax income rather than wealth as an objective fact, but that doesn't mean they always have to like it. Morgan by all accounts remained a very wealthy man in the 1930s, hence the understandable outrage he was making zero contribution to the Fisc.

In contrast to Morgan, Trump actually managed to lose all of his wealth. In fact, Trump's creditors famously had to grant him an "allowance" so he could maintain his personal brand to (hopefully) pay them back. As such it's harder to understand why people are so upset with Trump for not paying taxes while he was in the process of losing everything. Maybe they just don't understand that he was actually broke?

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